York University - Schulich School of Business; Rady School of Management

Date Written: March 2000

Abstract

This paper develops a procedure for forecasting the distribution from which future stock prices/returns will be drawn fundamentally. Our methodology therefore provides a means for forecasting future stock prices and return volatilities and thus for fundamentally valuing assets such as stocks and stock options. Statistical tests reveal the desirability of our procedure over those currently in use. For example, our fundamental volatility forecasts outperform standard ARCH-based models in forecasting the volatility of stock returns, and fundamental prices from our procedure reject bubbles and excess stock market volatility while prices from traditional fundamental models fail to do so.